Strengthening third-party audits to reduce pollution

Research by J-PAL affiliates Esther Duflo (MIT), Michael Greenstone (University of Chicago), Rohini Pande (Yale University), and Nicholas Ryan (Yale University) has shown that making environmental auditors more independent improved the accuracy of pollution audit reports and led industrial plants in the Indian state of Gujarat to reduce their emissions. Based on the results of the randomized evaluation, the Gujarat Pollution Control Board (GPCB) reformed its environmental auditing system in 2015, issuing new guidelines that require random assignment of environmental auditors. Members of the research team continue to work closely with officials in Gujarat and other Indian states on environmental policy design and evaluation.

The Problem

Auditors often lack incentives to accurately report pollution by industrial plants.

Rapid industrial growth in countries like China and India has greatly reduced poverty, but it has also led to severe air and water pollution, resulting in shorter and sicker lives for millions of people. The World Health Organization estimated that in 2016, urban air pollution caused 4.2 million deaths worldwide, most of which were in low- and middle-income countries.¹

To curb pollution, regulators need to know which plants are polluting most. One way to monitor industry compliance with environmental regulations is through third-party auditors. However, in most countries, auditors are managed and paid by the company they are auditing, creating a conflict of interest. In these systems, auditors may distort or falsify their reporting to maintain good relationships with the companies they audit. Furthermore, if auditors do not report the truth, there is no reason for the plants to comply since regulators will not know if they fail to meet pollution limits.

In 1996, the Indian state of Gujarat sought to strengthen its environmental regulatory framework by introducing the first third-party environmental audit system in India. The initial system, however, was thought to produce unreliable information about pollution. Recognizing this problem, GPCB sought out researchers to help reform the audit market in 2009.

The Research

Changing auditors’ incentives made them more likely to report the truth about pollution levels at industrial plants. In response, the plants polluted less.

J-PAL affiliated researchers collaborated with GPCB to design and evaluate a set of reforms in which auditors were randomly assigned to industrial plants, paid from a common pool, monitored for accuracy, and paid a bonus for accurate reports. Industrial firms in Ahmedabad and Surat, the two largest cities in Gujarat, were randomly assigned to participate in the new audit system.

The results were striking: under the new system, auditors were 80 percent less likely to submit a false pollution reading. In response to more accurate audits, industrial plants reduced emissions of air and water pollutants by 28 percent and this effect was driven by the highest-polluting plants.

For more about this research, read the evaluation summary.

The state is at the forefront of testing and implementing innovative policies that actually work, which is why we wanted to partner with this team of researchers. The visionary leadership of the state coupled with the strong evidence generated through the research has been a guiding force for implementing new ideas in our march towards sustainable development.

–Hardik Shah, Member Secretary of GPCB

From Research to Action 

GPCB’s commitment to testing various reform options ensured that the right policies could be effectively implemented and scaled.

Informed by the results of the evaluation, the GPCB has integrated the tested reforms into its strategy and expanded them across the state through a program known as the Environmental Audit Scheme.² Per the policy, industries manufacturing certain products are required to submit, and pay a fixed cost for, environment audits.

To implement the new reforms, GPCB worked with programmers to develop a new software system, known as the Extended Green Node (XGN), that tracks and manages all interactions between GPCB and polluting industrial plants. The new software, which was rolled out across the state in March 2015, automatically randomly assigns auditors to firms so that neither the auditors nor the regulators have discretion regarding who audits a particular firm. Industries are required to upload their environment audit reports—which cover manufacturing processes, air and water pollution, and safety and remedial measures—through the XGN.

Building on this successful partnership, members of the research team are continuing to work closely with officials in Gujarat and other Indian states on environmental policy design and evaluation.

In Gujarat, following the completion of the third-party study, J-PAL affiliates Greenstone, Pande, and Ryan, together with Anant Sudarshan, have partnered with the Ministry of Environment, Forest, and Climate Change (MoEFCC) and GPCB to evaluate the impact of the first-ever emissions trading program for particulate air pollution on air quality and compliance costs for industrial plants. The Emissions Trading Scheme (ETS) market is being implemented in the industrial city of Surat, where textile and dye mills are a major source of pollution.

The evaluation of ETS leverages data from continuous emissions monitoring systems (CEMS) devices, which were rolled out to plants across the state to send live readings of particulate emissions, thereby increasing transparency. Of 344 solid fuel-burning factories already implementing CEMS in Surat, half were randomly selected to participate in the first phase of a new ETS. Plants participating in the ETS market reduced their pollution emissions by 20 to 30 percent, relative to plants remaining in the command-and-control status quo regime.³ Based on these findings, the GPCB is expanding the project to other highly polluting clusters in Gujarat.

In Maharashtra, the same researchers have partnered with the Maharashtra Pollution Control Board (MPCB) to evaluate whether providing regulators and the public with more information about industrial plants’ pollution emissions increases regulatory compliance and reduces pollution.

The Maharashtra Star Rating program was launched in collaboration with MPCB in 2017 targeting large plants emitting high volumes of pollution. Under this scheme, treatment plants are rated on a scale from five stars (least polluting) to one star (most polluting), based on government tests of particulate matter emissions. These ratings are then publicly disclosed on the program website (mpcb.info).

The program is expected to put additional pressure on polluting industries and recognize the efforts of environmentally conscious industries. Pilot results suggest that being rated publicly increases the probability that a plant receives a legally actionable communication from a regulator.⁴ Based on these preliminary findings, the MPCB plans to begin training and enrolling industrial plants previously in the comparison group into the program.

This case study was published in October 2018. It was updated in September 2022 to include more information on the Emissions Trading Scheme in Gujarat and the star rating system in Maharashtra.

References

Duflo, Esther, Michael Greenstone, Rohini Pande, and Nicholas Ryan. 2013. "Truth-Telling by Third-Party Auditors and the Response of Polluting Firms: Experimental Evidence from India." The Quarterly Journal of Economics 128(4): 1499-1545. https://doi.org/10.1093/qje/qjt024.

Duflo, Esther, Michael Greenstone, Rohini Pande, and Nicholas Ryan. 2013. "What Does Reputation Buy? Differentiation in a Market for Third-party Auditors." American Economic Review: Papers Proceedings 103(3): 314-319. https://dx.doi.org/10.1257/aer.103.3.314.

World Health Organization. 2018. “Ambient (outdoor) air quality and health”, WHO Fact Sheets, May 2, 2018. https://www.who.int/news-room/fact-sheets/detail/ambient-(outdoor)-air-quality-and-health.